How to negotiate a Warranty Bond

The Warranty Bond is a guarantee which secures the Employer in the case the Contractor will not remedy the defects, if any, which may occur during the warranty period of the works. 

It is often issued by an insurance company or (especially in mid size international projects) by a bank and it provides the payment of a sum of money if the Contractor will not perform any remedial work as provided in the contract, a sum which will be used by the Employer to have the remedial works carried out by a third party.

Among the other bonds in international construction contracts the Warranty Bond is rather frequent in the construction of production plants or in complex infrastructure works.

Such bond is issued generally together with the Advance Payment Bond and the Performance Bond.

A.      How it works

Upon the occurrence of a defect, usually, the Employer and the Contractor start lengthy discussions on technical points and on the attributability of the defects to the Contractor.

Said discussions should be aimed at ascertaining whether the works have been carried out correctly or if the defects are attributable to the materials used by the Contractor. In reality, the Employer does not intend to be involved in detailed discussions and seeks only to have the defects remedied while the Contractor seeks to demonstrate either that the defects are minor issues or that they are not attributable to his activity. 

If the parties do not reach an agreement on the remedial works or if the Contractor does not carry out any remedial work, the Employer would be virtually entitled to call the warranty bond.

The entitlement and the manner for calling the bond will depend on the type of guarantee that the Contractor has issued and, if it is an on-demand bond, the Employer will be entitled to simply request from the guarantor the payment of the warranty bond without the need to prove the breach and default of the Contractor.

This is due to the specific nature of the on-demand bonds and if you wish to know more on them you can read our note:

B.      6 Tips to reduce the risks as Contractor

If you are a Contractor, you can consider the following 6 tips to reduce the risks involved in a warranty bond:

• ASCERTAIN first if the Warranty Bond is a separate and independent guarantee from the Performance Bond or if instead, the Performance Bond secures also the defects that will occur during the warranty period. Often, in fact, the Employer prefers to receive one single bond which will change its 'scope' after the takeover of the works. In such a case, the Performance Bond will secure the due execution of the works up to the takeover and afterward, it will secure the execution of the remedial works. It is generally preferable for a Contractor to issue two separate bonds so to have two different guarantees;

• ASCERTAIN if the bond is in the form of an on-demand bond;

• NEGOTIATE the bond so that the Employer will be entitled to call it only upon presentation, at least, of a declaration of a third party (for example from a technician appointed in advance by the parties) who will ascertain the occurrence of a defect attributable to the Contractor;

• NEGOTIATE, in the alternative, the bond so that the Employer shall be under the obligation to detail the alleged defects of the works and therefore the breach of the Contractor (said indications shall be of the utmost importance in case the bond is on-demand and in case of unlawful calling of the bond);

• NEGOTIATE the bond so that the Employer shall have to provide a documented quantification of the costs for the remedial works that he will carry out with the proceeds of the bond;

• OBTAIN from your subcontractor or suppliers warranty bonds substantially in line with the one issued in favour of the Employer so that if the defects are attributable to a supplier or a subcontractor, you will be in the position to recover the amount paid to the Employer. 

C.      Conclusions 

The Warranty Bond represents a normal protection for the Employer who will obtain in such a way a security in case the Contractor will not remedy defective works if any.  

If the Warranty Bond is issued in the form of an on-demand bond it could be a powerful tool and may be open to abuse by Employers in case, for instance, the defects are not actually attributable to the Contractors and the Employer is fully aware of that.

A fair compromise between the interest of the parties is often difficult to be reached but a careful negotiation will at least reduce the risks for the Contractors.

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"GUIDE ON BONDS IN INTERNATIONAL CONSTRUCTION CONTRACTS"